Investors are thought to have lost $500M, will pursue legal action.

The Securities and Exchange Commission has approved a plan (PDF) by the Nasdaq stock exchange to pay $62 million to investors. That sum covers the losses incurred during the bungled Facebook initial public offering (IPO) last year.

In May 2012, when the social network’s highly anticipated stock went public, there was an unexplained 30-minute delay before the stock began to be traded. By the time the stock was finally made available, a huge order volume overwhelmed Nasdaq.

According to the Wall Street Journal, banks are estimated to have lost around $500 million due to the “delay in the opening of Facebook trading and subsequent confusion over individual trades.” The kerfuffle didn’t fully resolve itself for three hours—an eternity in the age of high-frequency trading. Many banks, including UBS and Citigroup, have slammed the deal, adding that they will seek arbitration.

As Reutersreported at the time: “Orders that were supposed to be processed in three milliseconds were taking five milliseconds, said one person familiar with exchange operations. This proved to be a major problem: In the extra two milliseconds new orders flooded in, thwarting the system's ability to establish an opening price for the stock and leading to a backup in unprocessed orders.”

Needless to say, startup folks and bankers are decidedly ticked off about the shockingly low amount that they are being paid out. Meanwhile, TechCrunchwrote on Monday: “When Twitter or Dropbox go public, they should remember May 18, 2012… The debacle should push companies eying big IPOs to look at other exchanges.”

Promoted Comments

Call me a cynic; but it is just so hard to see capital markets as a mechanism for efficient capital allocation, rather than a bizarre sort of casino for twitch-gaming robots, when a 2ms delay substantially alters the valuation of a company.

What sort of value, exactly, is being measured if half a billion dollars worth of it can evaporate in less than a tenth of a second?

At first, the difference of 3ms and 5ms might seem so miniscule as to be not-an-issue.

In computing however, it can lead to a cascade problem where you have more requests pending than should be.

It's a funnel effect. The funnel in this case is "3 ms" wide. As long as a request is completed in that time, it fits through the funnel unhindered. However, when a 5ms request comes through, it backs up the funnel by 2ms. Another comes, the funnel is backed up even more. On and on until the funnel is very much overfull and other problems start happening.

So why is 3ms so important to the SEC? I mean, who makes transactions that fast anyway?

In an IPO, the banks do. They buy and sell the initial shares very fast based upon consumer demand. When more than one is involved, they can be very competitive about the purchase and sells of the initial offering because the money being moved is their own and if an opportunity is "handled" by a faster competitor, they could potentially lose that opportunity. That's where the 3 vs 5 ms really matters. When something "opens up" if you can't get in a "I got it!" faster than your competition, you lose.

Meanwhile the initial transactions fluctuate very much more than regular volume of established stock. That means the price is rapidly going up and down until it "settles". Losing transaction opportunities at "opportune" times means losing money on the "Investment Spread" - or the amount of the investment the bank stands to gain based upon the current price of a stock offering and the initial price.

When the opportunity is lost because the SEC cannot perform transactions under their normal transaction processing window, and when the lost opportunity is not due to any fault of the bank's systems, the banks have every right (IMO) to sue for the lost opportunity.

The valuation of that opportunity is very hard to calculate even after the fact because it's all hypothetical. ("Well, the stock WOULD HAVE BEEN xyz if my transactions had just gone through in time..")

But it's a very real problem when we're dealing with computerized transactions.

1522 posts | registered Aug 25, 2011

Cyrus Farivar
Cyrus is a Senior Tech Policy Reporter at Ars Technica, and is also a radio producer and author. His latest book, Habeas Data, about the legal cases over the last 50 years that have had an outsized impact on surveillance and privacy law in America, is due out in May 2018 from Melville House. He is based in Oakland, California. Emailcyrus.farivar@arstechnica.com//Twitter@cfarivar

Call me a cynic; but it is just so hard to see capital markets as a mechanism for efficient capital allocation, rather than a bizarre sort of casino for twitch-gaming robots, when a 2ms delay substantially alters the valuation of a company.

What sort of value, exactly, is being measured if half a billion dollars worth of it can evaporate in less than a tenth of a second?

Call me a cynic; but it is just so hard to see capital markets as a mechanism for efficient capital allocation, rather than a bizarre sort of casino for twitch-gaming robots, when a 2ms delay substantially alters the valuation of a company.

What sort of value, exactly, is being measured if half a billion dollars worth of it can evaporate in less than a tenth of a second?

I read a really good book (The Divine Right of Capital) which, among other things, argues that the folks on Wall Street are not in any sense investors - for precisely the reasons you get at. When your sole objective is to buy and turn around quickly selling high, you aren't an investor - you are a speculator.

Did Morgan Stanley do what it was actually supposed to do and price Facebook appropriately, and that the lack of an "IPO bump" meant that Facebook raised as much capital as it possibly could from the IPO?

If so, these bankers are whining because MS didn't "screw over" facebook and artificially underprice the IPO just so the bankers could get most of the capital out of the IPO as opposed to facebook. Sounds like they are just trying to recoup this money using the NASDAQ glitch as an excuse.

I don't know what contractual obligations Nasdaq was under in this case, but I'm kind of hoping there were none. No sympathy for HFT, sorry.

Agreed. HFT is speculation, a near opposite of investing, and doesn't generate any actual wealth in society. It is a pointless and unproductive activity for society to be encouraging and the effort would be better spent elsewhere. Perhaps more debacles will convince people to do just that.

I don't know what contractual obligations Nasdaq was under in this case, but I'm kind of hoping there were none. No sympathy for HFT, sorry.

Agreed. HFT is speculation, a near opposite of investing, and doesn't generate any actual wealth in society. It is a pointless and unproductive activity for society to be encouraging and the effort would be better spent elsewhere. Perhaps more debacles will convince people to do just that.

Well, the argument is that HFT creates liquidity and defines a price, making it easier to acquire and dispose of actual investments.

But, yeah, when the programmatic trading volume is a huge multiple of the "real" trading volume, and being able to respond in microseconds becomes a big issue that people spend lots of money on, you've gotta ask if we need quite that much liquidity. And when it gets to the point that they're selling visibility into the order queue, you know you're in la-la land.

Personally I suspect we'd all be better off if the whole thing were run as a sealed-bid auction at an interval of minutes.

This proved to be a major problem: In the extra two milliseconds new orders flooded in, thwarting the system's ability to establish an opening price for the stock and leading to a backup in unprocessed orders.

At first, the difference of 3ms and 5ms might seem so miniscule as to be not-an-issue.

In computing however, it can lead to a cascade problem where you have more requests pending than should be.

It's a funnel effect. The funnel in this case is "3 ms" wide. As long as a request is completed in that time, it fits through the funnel unhindered. However, when a 5ms request comes through, it backs up the funnel by 2ms. Another comes, the funnel is backed up even more. On and on until the funnel is very much overfull and other problems start happening.

So why is 3ms so important to the SEC? I mean, who makes transactions that fast anyway?

In an IPO, the banks do. They buy and sell the initial shares very fast based upon consumer demand. When more than one is involved, they can be very competitive about the purchase and sells of the initial offering because the money being moved is their own and if an opportunity is "handled" by a faster competitor, they could potentially lose that opportunity. That's where the 3 vs 5 ms really matters. When something "opens up" if you can't get in a "I got it!" faster than your competition, you lose.

Meanwhile the initial transactions fluctuate very much more than regular volume of established stock. That means the price is rapidly going up and down until it "settles". Losing transaction opportunities at "opportune" times means losing money on the "Investment Spread" - or the amount of the investment the bank stands to gain based upon the current price of a stock offering and the initial price.

When the opportunity is lost because the trading platform cannot perform transactions under their normal transaction processing window, and when the lost opportunity is not due to any fault of the bank's systems, the banks have every right (IMO) to sue for the lost opportunity.

The valuation of that opportunity is very hard to calculate even after the fact because it's all hypothetical. ("Well, the stock WOULD HAVE BEEN xyz if my transactions had just gone through in time..")

But it's a very real problem when we're dealing with computerized transactions.

Edit: As pointed out, I did originally say the the SEC performed the transaction which was an error on my part. The SEC only "oversees" the transactions to some degree or another. Edited for accuracy.

I don't understand how you can guarantee or sue for money when you are "investing" in a company and it trades late. There is no minimum value guarantee when you buy a stock and expect to resell it, that's why so many retirement plans went down on the economic slump, do they get money back for the bank screw-ups? Investing is risky and you should not get to sue just because stock made it to the floor late or everyone over valued a company like Facebook that reached a cash flat time, which is why it went public to raise more money. Think that one over before you buy stock in the next hot company, even though Facebook financials weren't public, most of use non-major investors knew that Facebook was sentimental value not monetary.

What is funny is the IPO price was crap anyway because facebook is trading at around 25 bucks right now. It was clearly overvalued from the start and likely will never be able to regain a share price anywhere near the IPO price.

Call me a cynic; but it is just so hard to see capital markets as a mechanism for efficient capital allocation, rather than a bizarre sort of casino for twitch-gaming robots, when a 2ms delay substantially alters the valuation of a company.

What sort of value, exactly, is being measured if half a billion dollars worth of it can evaporate in less than a tenth of a second?

This sounds like an experiment waiting to happen. Give a lab fruit fly $50k, and see how much it can make in the stock market before it dies.

Call me a cynic; but it is just so hard to see capital markets as a mechanism for efficient capital allocation, rather than a bizarre sort of casino for twitch-gaming robots, when a 2ms delay substantially alters the valuation of a company.

What sort of value, exactly, is being measured if half a billion dollars worth of it can evaporate in less than a tenth of a second?

I read a really good book (The Divine Right of Capital) which, among other things, argues that the folks on Wall Street are not in any sense investors - for precisely the reasons you get at. When your sole objective is to buy and turn around quickly selling high, you aren't an investor - you are a speculator.

Yeah. An investment is something you put money into to see it grow over time, usually b/c there's a long-term monetary gain, like dividends, greater control of a market segment, a company/service/product you believe in, etc.

Most "investing" these days is just folks setting automated low/high acquisition/dump requests to a broker. It's all pretty blind. There is still some research going on by some to see what is worth buying into, but most investing is not for the long-run. Day trading is at an all-time high.

However, the benefit to that is that if day-traders won't touch something for a short-term profit, you can usually snatch it up and hold it for months or years until it rebounds. You spend more time waiting for your payoff, but if you're patient and you can make a more calculated investment decision this way.

What is funny is the IPO price was crap anyway because facebook is trading at around 25 bucks right now. It was clearly overvalued from the start and likely will never be able to regain a share price anywhere near the IPO price.

If I remember correctly, and it's been a while so I might not be, most IPO prices are higher than the price an equity will settle at when all is said and done. It's why the IPO is only really a money-making possibility for people/entities that get the shares before the IPO at significantly lower prices than the initial public price.

At first, the difference of 3ms and 5ms might seem so miniscule as to be not-an-issue.

In computing however, it can lead to a cascade problem where you have more requests pending than should be.

It's a funnel effect. The funnel in this case is "3 ms" wide. As long as a request is completed in that time, it fits through the funnel unhindered. However, when a 5ms request comes through, it backs up the funnel by 2ms. Another comes, the funnel is backed up even more. On and on until the funnel is very much overfull and other problems start happening.

So why is 3ms so important to the SEC? I mean, who makes transactions that fast anyway?

In an IPO, the banks do. They buy and sell the initial shares very fast based upon consumer demand. When more than one is involved, they can be very competitive about the purchase and sells of the initial offering because the money being moved is their own and if an opportunity is "handled" by a faster competitor, they could potentially lose that opportunity. That's where the 3 vs 5 ms really matters. When something "opens up" if you can't get in a "I got it!" faster than your competition, you lose.

Meanwhile the initial transactions fluctuate very much more than regular volume of established stock. That means the price is rapidly going up and down until it "settles". Losing transaction opportunities at "opportune" times means losing money on the "Investment Spread" - or the amount of the investment the bank stands to gain based upon the current price of a stock offering and the initial price.

When the opportunity is lost because the SEC cannot perform transactions under their normal transaction processing window, and when the lost opportunity is not due to any fault of the bank's systems, the banks have every right (IMO) to sue for the lost opportunity.

The valuation of that opportunity is very hard to calculate even after the fact because it's all hypothetical. ("Well, the stock WOULD HAVE BEEN xyz if my transactions had just gone through in time..")

But it's a very real problem when we're dealing with computerized transactions.

So when do regular people get to sue banks for their losses, because the banks bungled things up?

When the opportunity is lost because the SEC cannot perform transactions under their normal transaction processing window, and when the lost opportunity is not due to any fault of the bank's systems, the banks have every right (IMO) to sue for the lost opportunity.

I am strongly questioning why an editor would promte this comment. The SEC does not 'perform transactions'. The SEC has nothing to do with the back-end processing centers of the banks and the SEC is not being sued.

This is not a nitpick, this is a fundamental ignorance of the basic functioning of the financial system. It's like saying that a hard disk is responsible for video output. It implies a fundamental misunderstanding of who profits from IPOs, which implies a fundamental ignorance of how many people get screwed and how some other people make millions of dollars for almost no reason, which implies a fundamental lack of understanding of the Tech bubble of the 1990s, which implies that this type of ignorance will lead us directly into another disastrous bubble again sometime soon that we can ill afford with 14 trillion dollars in national debt.

If you want to prevent another Recession, I would humbly suggest reading a few books about IPOs and bubbles, namely, Andy Kessler's: he was a techie who became a hedgie. Then maybe Trading with the Enemy, then Devil Take The Hindmost, and then a few others.

At first, the difference of 3ms and 5ms might seem so miniscule as to be not-an-issue.

In computing however, it can lead to a cascade problem where you have more requests pending than should be.

It's a funnel effect. The funnel in this case is "3 ms" wide. As long as a request is completed in that time, it fits through the funnel unhindered. However, when a 5ms request comes through, it backs up the funnel by 2ms. Another comes, the funnel is backed up even more. On and on until the funnel is very much overfull and other problems start happening.

So why is 3ms so important to the SEC? I mean, who makes transactions that fast anyway?

In an IPO, the banks do. They buy and sell the initial shares very fast based upon consumer demand. When more than one is involved, they can be very competitive about the purchase and sells of the initial offering because the money being moved is their own and if an opportunity is "handled" by a faster competitor, they could potentially lose that opportunity. That's where the 3 vs 5 ms really matters. When something "opens up" if you can't get in a "I got it!" faster than your competition, you lose.

Meanwhile the initial transactions fluctuate very much more than regular volume of established stock. That means the price is rapidly going up and down until it "settles". Losing transaction opportunities at "opportune" times means losing money on the "Investment Spread" - or the amount of the investment the bank stands to gain based upon the current price of a stock offering and the initial price.

When the opportunity is lost because the SEC cannot perform transactions under their normal transaction processing window, and when the lost opportunity is not due to any fault of the bank's systems, the banks have every right (IMO) to sue for the lost opportunity.

The valuation of that opportunity is very hard to calculate even after the fact because it's all hypothetical. ("Well, the stock WOULD HAVE BEEN xyz if my transactions had just gone through in time..")

But it's a very real problem when we're dealing with computerized transactions.

If the system is FIFO it shouldn't matter that the trade was delayed by 2 ms. I realize that this creates a cup runneth over situation, but everyone is still at the same "disadvantage".

For all we know this saved the banks $500M.

The SEC doesn't perform the transactions. In theory they oversee that the transactions were performed correctly - in reality they don't do shit.

What is funny is the IPO price was crap anyway because facebook is trading at around 25 bucks right now. It was clearly overvalued from the start and likely will never be able to regain a share price anywhere near the IPO price.

what is even funnier is how many people simply choose to forget 1999 and things like Pets.com. it is the modern form of 'gold fever', people are just inherently a-rational (aka stupid) when it comes to the idea of getting filthy rich really quick without doing any actual work. you can read these IPO stories over and over and anyone who mentions the bubbles of the past is instantly dismissed as a party pooper. They keep on reading websites like Business Insider without bothering to read about the true history of it's founder, Henry Blodgett. These are people who are willingly bamboozled, run amok, and led astray.

This wouldn't be a big problem, except that in our modern system, a few dozen stupid people in the right position of power are now able to destroy the entire financial system, as proven in 2008. It's like we put a bunch of high school dropouts in charge of the water system and shrug our shoulders when they decide to replace it with a sports drink... no wait, that was in a movie. Or was it a documentary? Because that is literally, quite literally what has happened to the financial system - it's basically a water system for money to flow. And when we put idiots in charge of this 'money flow utility' and don't bother to call them out, let alone understand what they are doing, they will keep pumping Brawndo into it.

If the system is FIFO it shouldn't matter that the trade was delayed by 2 ms. I realize that this creates a cup runneth over situation, but everyone is still at the same "disadvantage".

For all we know this saved the banks $500M.

The SEC doesn't perform the transactions. In theory they oversee that the transactions were performed correctly - in reality they don't do shit.

The problem is that the "first in" response could end up being someone else. It's true that "everyone has the same disadvantage" - at least theoretically - but that doesn't mean that the situation should exist at all in the first place which is the problem.

In actuality, many things affect the instantaneous processing of a transaction including how many other transactions are being processed at the same time by you and by everyone else.

However, it's not likely the banks were saved any money by this. If demand didn't turn out to meet expectations, it would likely have resulted in a savings of money to the bank. But since it was in high demand, the spread moves the other direction.

I don't know what contractual obligations Nasdaq was under in this case, but I'm kind of hoping there were none. No sympathy for HFT, sorry.

Agreed. HFT is speculation, a near opposite of investing, and doesn't generate any actual wealth in society. It is a pointless and unproductive activity for society to be encouraging and the effort would be better spent elsewhere. Perhaps more debacles will convince people to do just that.

Actually HFT is more like skimming. They use sheer speed to take fractions of a penny per share off of your transactions.

... But it's a very real problem when we're dealing with computerized transactions.

I agree with you that the 2ms make a difference, but so what? Can I sue Walmart if I don't get my hands on a product offered at a low price? If only they had the volume, I could have purchased 1000 for $10 and then sold them for $20.

In this case, maybe some institutions have a deal with the NASDAQ saying they have a right to 3ms transactions, and others 5ms transactions... and that is why they are suing? If that is the case though, it just highlights the bigger problem with stock exchanges - they are rigged in favour of big business / players... everyone else gets hosed.

The stock market has been turned into something other than what it was intended to do...